Derivative Security: Definition
A derivative security is a financial instrument having dependence on the value of the other variables. The other variable may be any commodity or stocks. The word derivative comes from the word derive. The commodity is the base of a financial instrument having some value. Its value is based upon the underlying commodity that we took as a derivative basis.
Derivative securities are traded in Over The Counter (OTC) as well as structured stock exchanges. Wherever the derivatives are being traded, the places collectively are known as “derivative market”. However, there is some difference in transactions and procedural commitments while trading in OTC and structured stock exchange.
Derivative market is a name of someplace where two unrelated parties enter in a contract having distinguished beliefs about the market motions. For instance, one party believes the market will go up while the other thinks that the market will go bearish in the upcoming duration. Well, it is difficult to map out the correct anticipation prior to the happening of actual event. In a nutshell, investors are lean-to hedge the potential risk due to market turn around in a particular position held by them.
Derivatives securities are widely used to hedge the associated risk for a future time period. The risk can be hedged or covered through the derivation of the underlying asset or other financial instruments to the derivative contract. However, these securities are now being traded by the speculators as well in order to get the benefit of the expected spread. This is not about hedging the risk but is exercised to earn profit as we do through the means of businesses.
Types of Derivative Securities
Modern derivates are traded on Gold, Silver, Currency, Wheat, Rice, Cotton, Crude Oil, and other agricultural and financial instruments. There are four types of derivative securities with a bit of structural difference present.
The types include Futures, Forwards, Options, and Swaps. Out of these four, only forward is not traded informal stock exchange because it is a bit informal. Apart from this, there is no difference between the operative procedure of future and forward contract. Forward contract is executed in over-the-counter market in the personal capacity.
However, derivatives can be traded in international virtual forums as well. Along with this, local investors can move towards global markets such as New York Stock Exchange (NYSE), Osaka Mercantile Exchange (OMEX), Tokyo Commodity Exchange (TCEX), Bombay Stock Exchange (BSE), etc.